Fed Tapering: Will it Be Different This Time?

As the Federal Reserve transitions from merely talking about tapering its bond holdings to actually tapering, investors may be left wondering what it might mean for the markets and their portfolios. Here’s a quick review of the Fed’s policies, what happened the last time the Fed tapered, and whether it will be different this time.

How we got here

In March 2020, the Federal Reserve was staring down the runway of an unprecedented pandemic with dire economic implications. As a result, the Fed quickly cut the federal funds rate to the range of zero to 0.25% from 1.5% to 1.75% and started purchasing large amounts of Treasuries and agency mortgage-backed securities (MBS) to provide additional stimulus to the economy above and beyond the rate cuts. These large-scale asset purchases are what is commonly referred to as quantitative easing (QE). The goals of quantitative easing are to:

  • Support the smooth functioning of the financial markets
  • Provide additional stimulus to the economy by lowering borrowing costs
  • Put downward pressure on long-term yields to boost investment
  • Support the MBS and commercial mortgage-backed securities (CMBS) markets through lowering interest rates for residential and commercial mortgages.

Fast forward through the shortest recession on record and the economy is rebounding strongly. The Fed’s economic forecasts for the end of 2021 show economic growth rising at a 7.0% pace, core inflation at 3.0%, and an unemployment rate of 4.5%.

Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents

Source: Federal Reserve Board, as of 06/16/2021.
Notes: For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. The central tendency excludes the three highest and three lowest projections for each variable in each year. The range for a variable in a given year includes all participants' projections, from lowest to highest, for that variable in that year. Longer-run projections for core PCE are not collected.

As the economic picture improves, it is not surprising that the Fed would start talking about scaling back its stimulus. Although it’s waiting for “substantial further progress” towards its dual mandate of an average inflation target of 2% and full employment, it looks like those benchmarks may be reached sooner rather than later, given its forecasts for 2021.